Inventory

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Hard Test

Hard Test

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1. Which inventory method will give the lowest cost of goods sold in an inflationary environment?

a. FIFO perpetual
b. LIFO periodic
c. Weighted average
d. each method listed will give the same cost of goods sold

Answer

A. An inflationary environment means that costs are increasing. The lowest cost of goods sold will be from the first items being sold first because they have a lower cost. First items sold first is FIFO. Periodic or perpetual does not impact the answer.

2. When a company operates in an inflationary environment

a. the company will have larger income using LIFO than FIFO
b. the company will have lower cost of goods sold using LIFO than FIFO
c. inventory will have a lower value under LIFO than FIFO
d. net income is always the same under FIFO and LIFO

Answer
C. An inflationary environment means that costs are increasing. The highest cost of goods sold will be from the last items being sold first, LIFO (b). When cost of goods sold is higher, ending inventory is lower. When cost of goods sold is higher, net income is lower (a.).
3. The company included $20,000 of goods on consignment that were being stored in the company’s warehouse in inventory reported on the balance sheet. As a result

a. inventory is reported properly
b. cost of goods sold is lower
c. income is lower
d. inventory is understated

Answer
B. Items on consignment are not owned by the company and should not be reported as inventory on the balance sheet. Inventory is incorrectly overstated. When ending inventory is overstated (too high), cost of goods sold is understated (too low) and net income is overstated (too high).  
4. A company that uses the net method to record inventory transactions will report income __________ than a company that uses the gross method given inventory remains constant and the discount is not taken.

a. higher
b. lower
c. the same as
d. depends on the total purchases of the company

Answer
C. How the company records a purchase transaction has no impact on the total net income of the company. The total expense reported will be the same. The gross method will record a higher purchase cost leading to a higher CGS when the discount is not taken and the net method will record an interest expense when the discount is not taken.  
5. Which of the following is not true?

a. when using the perpetual moving average the total cost of goods sold will not equal total available less ending inventory
b. the gross method of recording inventory transactions uses the purchase discount account.
c. the net method of recording inventory transactions may use the purchase returns account
d. FIFO periodic will give the same ending inventory value as FIFO perpetual

Answer
A. When using any method of determining ending inventory, total available less cost of goods sold will always equal ending inventory. All other statements are true. The purchase returns account is used for the periodic method for both net and gross.
6. The difference in net income when using FIFO as compared to LIFO will be minimized when

a. on average inventory is held for 30 days
b. on average inventory is held for one year
c. LIFO is used for tax purposes
d. LIFO is used for financial reporting purposes

Answer
A. When inventory sells quickly, there will be minimal difference in the first cost and the last cost of inventory still on hand. (c. & d.) do not cause a the difference in income for LIFO and FIFO which is caused by inflation or deflation.
7. When beginning inventory is understated by $50,000 and ending inventory is overstated by $20,000, net income will be

a. understated by $70,000
b. overstated by $70,000
c. understated by $30,000
d. overstated by $30,000

Answer

B. Beginning inventory too low will make cost of goods sold too low. Ending inventory too high will make cost of goods sold too low. Both errors reduce cost of goods sold, so the amounts are added to make cost of goods sold too low by $70,000. (Refer to the formula BI + Purchases – EI = CGS)

8. Which of the following is an advantage of using FIFO?

a. it allows gross profit to be reported 100% accurately
b. it reports inventory on the balance sheet at approximate replacement cost
c. it always reports the asset on the balance sheet at the lowest amount possible
d. it always maximizes net income

Answer
B. FIFO will leave the latest purchases as inventory. The latest purchases are closest to replacement cost. Inventory methods are estimates and are not 100% accurate (a.) FIFO does not always give a lower inventory value or a higher net income, this depends on if the company is experiencing inflation or deflation.
9. Which method results in the highest cash flow when inventory costs are rising?

a. FIFO
b. LIFO
c. Weighted average
d. inventory methods do not affect cash flows

Answer
B. LIFO gives the lowest net income when costs are increasing because it gives the highest cost of goods sold. Lower net income leads to lower taxes paid which leads to higher cash flows. Moving costs from inventory to cost of goods sold does not change cash flows. The amount of taxes paid on reported income does impact cash flows.
10. When applying lower of cost or market and inventory is decreasing in value, net income for the period will

a. be higher since reported cost of goods sold will be lower
b. be lower since reported cost of goods sold will be higher
c. be the same since lower of cost or market does not affect net income
d. be higher since the adjustment to market will occur when the inventory is sold due to the matching concept

Answer
B. Inventory that is decreasing in value must be decreased. When an asset is lower an expense occurs. This expense is not always called cost of goods sold, but it is always reported as cost of goods sold. Higher cost of goods sold gives lower net income. The adjustment is made when it is discovered the inventory is losing value (d).
11. A company sells one product. At the beginning of the year the company had 10,000 finished products in inventory at a cost to manufacture of $11 each. During the year the company manufactured 3 different batches of product consisting of 12,000, 14,000 and 8,000 units at a total cost of $135,000, $161,000 and $96,000 respectively in this order. During the year the company sold 41,000 units for $800,000 in sales dollars. Shipping costs are $0.30 for each product shipped.

Compute the value of ending inventory and cost of goods sold for the period using
the periodic method and
A. FIFO
B. LIFO
C. Average cost

Answer
First you must determine the cost per unit for each purchase. Divide total cost by total quantity produced to get the cost per unit.

Batch Total Cost Quantity Cost per unit
1 $135,000 12,000 $11.25
2 $161,000 14,000 $11.50
3 $ 96,000 8,000 $12.00

Shipping costs are a selling cost and are not part of the cost of the product.

Second: Put inventory in order and determine available quantity and cost.

  Quantity Cost per Total Cost
Beginning 10,000 $11.00 $110,000
Batch 1 12,000 $11.25 $135,000
Batch 2 14,000 $11.50 $161,000
Batch 3 8,000 $12.00 $ 96,000
     Total Available 44,000   $502,000

Then compute cost of goods sold and ending inventory for each method.

11.A. FIFO
First ones manufactured are the first ones sold.
Go down from the top until the total quantity is 41,000.

  Quantity Cost per Total Cost
Beginning 10,000 $11.00 $110,000
Batch 1 12,000 $11.25 $135,000
Batch 2 14,000 $11.50 $161,000
Batch 3 5,000 $12.00 $ 60,000
Total sold 41,000   $466,000 = Cost of goods sold

Use only 5,000 of Batch 3 because that is all that is required to total to 41,000 sold.

Once you have determined the cost of goods sold, ending inventory is always

Available                                $502,000
– Cost of goods sold             ($466,000)
= Ending inventory                $ 36,000

Ending inventory: 300 x $12 = $36,000

11.B. LIFO
Last ones purchased are the first ones sold.
Start at the bottom and go up until the total sold is 41,000 units.

  Quantity Cost per Total Cost
Batch 3 8,000 $12.00 $ 96,000
Batch 2 14,000 $11.50 $161,000
Batch 1 12,000 $11.25 $135,000
Beginning 7,000 $11.00 $ 77,000
Total sold 41,000   $469,000 = Cost of goods sold

Use only 7,000 of the beginning inventory because that is all that is required to total 41,000 sold.

Ending inventory is always

Available                          $502,000 see above
– Cost of goods sold       ($469,000)
= Ending inventory          $ 33,000

11.C. Weighted Average method:
Use “Available” to get the average cost per unit

       Total $ Available          $502,000 =
Total Quantity Available       44,000

$11.409 average cost per unit

Units sold 41,000
x Average cost per unit $11.409
= Cost of goods sold $467,769

   Units ending inventory                  3,000
x Average cost per unit                $11.409
= Ending inventory                       $34,227

Ending inventory is always

Available                                 $502,000
– Cost of goods sold              ($467,769)
= Ending inventory                  $ 34,231

$4 difference due to rounding the moving average cost per unit

12. The company purchased inventory on account for a cost of $80,000 on June 1st of the current year with terms of 1.2/10,n30. Additional freight paid directly to the shipper for the purchase was $850. On June 14, goods with a cost of $24,000 were sold for a price of $36,000. On June 18th, $2,000 of goods was returned to the supplier. On June 26th, a customer paid $21,000 for goods that cost the company $9,000. Inventory actually counted at the end of June was valued at a cost of $77,400. Beginning inventory on June 1st was $33,000. All amounts are stated in gross terms. The company uses the periodic net method of accounting for inventory.

Compute Cost of Goods Sold.

Answer
The company uses the net method. All gross amounts need to be converted to net amounts.

Purchase: 80,000 net of 1.2% = 960 = 79,040 net
Freight In: no discount offered from the shipper
Return: 2,000 net of 1.2% = 24 = 1,976 net
Beginning Inventory: 33,000 net of 1.2% = 396 = 32,604 net
Ending Inventory: 77,400 net of 1.2% 929 = 76,471 net
Payment – not used, payment is too late to take the discount

Cost of goods sold is not recorded using the periodic method.

Compute Cost of Goods Sold using net amounts:

Beginning FG Inventory      $    32,604
+ Purchases                        $    79,040
+ Freight In                          $         850
– Purchase returns               $    (1,976)
= Available for sale              $  110,518
– Ending FG Inventory         $  (76,471)
= Cost of Goods Sold          $    34,047

13. The company’s inventory balance according to the physical count taken at the end of the year was $375,000. The accountant preparing the financial statements discovered the following:

a. On December 28th, $8,000 of goods were shipped F.O.B. destination to customers. The goods were received on January 2nd.

b. On December 28th, $6,000 of goods were shipped F.O.B. shipping to customers. The goods were received on January 2nd. The goods were included in the inventory balance.

c. $12,000 of inventory held in the warehouse on consignment was included in the inventory balance.

Gross profit based on the above inventory count was $600,000. Compute the correct gross profit?

Answer
a. Inventory shipped FOB destination is stilled owned by the company until it is received by the customer. The customer received it on 1/2, so on 12/31 the company should include the amount as inventory. It was not included because it was not in the warehouse on 12/31, it had been shipped out.

Ending inventory must be increased by $8,000

b. Inventory shipped FOB shipping is owned by the customer on the date it is shipped.
The inventory was included in the count and must be taken out of the ending balance.

Ending inventory must be decreased by $6,000

c. Goods owned on consignment are not owned by the company and should not be
included in the ending inventory balance.

Ending inventory must be decreased by $12,000

Total change is + 8,000 – 6,000 – 12,000 = decrease of 10,000 to inventory

Beginning Inventory
+ Purchases
– Ending inventory               (10,000) Ending inventory is less so
= Cost of goods sold         + 10,000 cost of goods sold is more

Sales
– cost of goods sold              +10,000 Cost of goods sold is more so
= Gross profit                        (10,000) gross profit will be less

Previous gross profit          600,000
Lower Gross profit             (10,000)
Adjusted Gross profit         590,000

14. The Company purchased 750 products for resale on the 5th of each month during the 1st quarter of the year. The cost was $6 in January and the cost was reduced 10% for February and then 10% again in March. Beginning inventory was 200 units at a cost of $6.50 each. Sales during the 1st quarter were as follows: January 9th 300 February 2nd 600 March 17th 775

Compute cost of goods sold reported on the income statement and ending inventory reported on the balance sheet for the quarter using the perpetual method and
A. FIFO
B. LIFO
C. Moving Average

Answer
FIFO is the same for periodic and perpetual. Do the easier periodic computation.

Inventory on 1/1 200 x $6.50 = $ 1,300
1/5 750 x $6.00 = $ 4,500
2/5 750 x $5.40 = $ 4,050
3/5 750 x $4.86 = $ 3,645
Available 2,450 $13,495
– Sales during quarter (1,675)      ??
= Ending Inventory 3/31      775      ??

First ones purchased are the first ones sold.
Start from the top and go down until total units sold is 1,675.

Inventory on 1/1 200 x $6.50 = $ 1,300
Purchase 1/5 750 x $6.00 = $ 4,500
Purchase 2/5 725 x $5.40 = $ 3,915
Total Sold 1,675 $ 9,715

Ending inventory is always

Available                               $13,495
– Cost of goods sold           ($ 9,715)
= Ending inventory             $ 3,780

14.B) LIFO

1st Set up purchases and sales in date order. Only units on hand before the sale
are included in units sold, starting with the last one purchased.

                                                                                        Purchases                         Sales

                                                                                           Cost                                  Cost
                                                                        Units       per-unit           Sold       per unit    CGS

January 1        Beginning Balance                  200             $6.50
January 5        Purchased                               750             $6

January 9        Sold                                        (300)                               300           $6          $1,800 from 1/5

February 2      Sold                                         (600)                              450            $6         $2,700 from 1/5
                                                                                                              150            $6.50    $   975 from BI

February 5      Purchased                                750             $5.40
March 5           Purchased                                750            $4.86

March 17         Sold                                         (775)                               750           $4.86     $3,645 from 3/5
                                                                                                                  25           $5.40     $ 135 from 2/5
                                                                                                                                               _______
                                                                                                      Total CGS:                        $9,255

Ending Inventory:
From Beg Inventory             50 x $6.50 = $ 325
From 2/5 Purchase          725 x $5.40 = $3,915
Total Ending Inventory                            $4,240

Double check your computations.

Available                          $13,495
– Cost of goods sold        ($ 9,255)
= Ending inventory           $ 4,240

Ending Inventory:
From Beg Inventory 50 x $6.50 = $ 325
From 2/5 Purchase 725 x $5.40 = $3,915
Total Ending Inventory $4,240

Double check your computations.

Available                            $13,495
– Cost of goods sold          ($ 9,255)
= Ending inventory             $ 4,240

14.C)  Perpetual Moving Average:   

A new moving average is computed after each purchase. 
The cost of the sale is recorded at the most recent moving average cost per unit. 
Sales do not change the moving average.

                                                                    Purchases                                                Sales

                                                                       Cost                     Moving                        Cost
                                                         Units x per-unit = Total      Average          Sold x per unit   =   CGS

January 1          Beginning                200     $6.50        $1,300
January 5          Purchased               750     $6             $4,500
             Moving Average                   950                      $5,800      $6.11

January 9          Sold                        (300)                    ($1,833)                       300      $6.11        $1,833

February 2        Sold                         (600)                    ($3,666)                       600      $6.11       $3,666

February 5        Purchased                750      $5.40       $4,050
March 5             Purchased               750       $4.86       $3,645
            Moving Average                  1,550                     $7,996      $5.16

March 17          Sold                         (775)                   ($3,999)                        775       $5.16      $3,999
                                                                                                                                                     _______
             Ending Inventory                    775                     $3,997

                                                                                                  Total CGS:                                    $9,498

Double check your computations.

   Units ending inventory                 775
x Average cost per unit                $5.16
= Ending inventory                     $3,999

Ending inventory is always

   Available                               $13,495
– Cost of goods sold                ($ 9,498)
= Ending inventory                   $ 3,997

$2 difference due to rounding in moving average cost to dollars and cents.